Published: September 20, 2007

The results, especially the write-down of $940 million in loans made to finance acquisitions during the equity buyout boom, signaled that the top Wall Street investment firms have begun to clear those problems off their books.

Moreover, the results, which missed analysts' estimates, showed that the aggressive increase in the firm's risk profile under its chief executive, John J. Mack, which drove profits to record levels early this year, can have a downside when markets turn cautious.

With Mr. Mack in charge, the firm has focused more on hot, lucrative segments like private equity, proprietary trading and hedge funds. And having decided to spin off Discover, its credit card unit, Morgan Stanley is now more aligned with the vicissitudes of the marketplace as was amply demonstrated yesterday.

Despite the hiccup, top executives said yesterday that there would be no backing away from that approach.

''Taking risk is crucial for our survival,'' said David H. Sidwell, Morgan Stanley's chief financial officer, who will be stepping down at the end of the year. ''You have to be willing to use your capital.''

The profit decline -- the first under Mr. Mack's leadership -- raised the possibility that Morgan Stanley, as well as other firms on the street, might impose additional layoffs by the end of the year if the markets do not show significant improvement.

Mr. Sidwell said that the firm's mortgage-related areas would be the most likely spot for reductions and that the firm would also be looking at divisions involved in providing lending and advice to private equity firms.

Morgan Stanley recorded profit from continuing operations for the quarter ended Aug. 31 of $1.47 billion, or $1.38 a share, down 7 percent from $1.59 billion, or $1.50 a share, in the period a year ago and down a sharper 38 percent from the second quarter. Analysts surveyed by Thomson Financial had forecast profit of $1.54 a share. The results exclude the credit card unit. With the credit card unit, net income was $1.54 billion, or $1.44 a share.

Taking the brunt of the market malaise was the firm's institutional division, which includes Morgan's trading, lending and investment banking units. The unit saw its pretax profits slip 49 percent from the previous quarter.

The markdown of loans cut earnings by 33 cents a share, the firm said. Morgan Stanley also disclosed that it had about $480 million in trading losses in its quantitative trading segment.

Proprietary trading, a driver in past quarters and a recent area of focus for the firm, was very weak this quarter, down 71 percent from the previous quarter. Quantitative trading strategies, especially at some of the large hedge funds, have been punished because of illiquid and unpredictable market movements.

''It's never pretty when you have to take a billion-dollar write-down,'' said Michael Mayo, an analyst at Deutsche Bank. ''But that is part of their overhead for being involved in the private equity business. The firm still managed to generate a return on equity of 17 percent.''

Two areas of the firm that in the past have been weak performers, brokerage and asset management, bucked the downward trend by showing profit increases compared with the second quarter. Brokerage was up 9 percent and asset management was up 62 percent, yet given the small size of their businesses, the results were not enough to seriously mitigate the decline in the securities division.

The results disappointed investors, and shares of Morgan Stanley closed down 2.1 percent, or $1.48, at $67.03.

On Tuesday, Lehman Brothers, which reported a 3 percent drop in profit, also said that its earning had been hurt by write-downs in the mortgage market and loans to private equity firms that the bank has not been able to sell.